DECISION
1. This
is the appeal of Vocalspruce Limited (“the Appellant”) against a notice of
amendment issued on 11 December 2009 by HMRC (“the Respondents”) in relation to
the corporation tax return of the Appellant for the accounting period ended on
31 December 2004. The effect of the amendment was to increase the taxable
profits of the Appellant by £3,674,561.
2. As
we will describe, this case is a lead case under rule 18 of the Tribunal
Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. A number of related
cases, with common or related issues of fact and law, have been stood behind
this appeal.
3. The
dispute arises in relation to certain intra-group financing arrangements and
transactions. In essence, the parent company, Brixton plc, subscribed for zero
coupon loan notes (“the loan notes”) in a number of group companies. Those
loan notes were then transferred to the Appellant for shares issued with a
nominal value equal to the then value of the loan notes, but also at a premium,
on terms that the premium would be paid up by capitalising profits arising on
the loan notes and appropriating those sums to the Appellant’s share premium
account.
4. The
Appellant claims that the credit that would otherwise be brought into account
for corporation tax purposes on the accrual of profits on the loan notes under
the loan relationships rules in the Finance Act 1996 is not brought into
account because the transactions fall within s 84(2)(a) of that Act. In
essence, the Appellant says that the profits on the loan notes were required to
be transferred to the share premium account, and that as such the effect of s
84(2)(a) is to remove such amounts from the scope of tax.
5. The
Respondents contend that the Appellant has not received any “amounts required
to be transferred” to its share premium account within the meaning of s
84(2)(a). The Respondents also say, but it applies only if they are wrong on
the first point, that para 12, Sch 9 FA 1996 applies to disregard the transfer
by the Appellant of profits on the loan notes to share premium account.
6. The
Appellant was represented by Jonathan Peacock QC and Michael Ripley. Julian
Ghosh QC appeared for the Respondents.
Lead case
7. As
mentioned earlier, this case is a lead case. It has common or related issues
with a number of related cases, which have been stayed. Subject to a right to
apply to the Tribunal for a direction to the contrary, the parties to the
related cases are bound by this decision in respect of the common or related
issues.
8. We
need not recite the common or related issues of fact, as that will be apparent
from our description of the facts of this case. However, we set out here the
common or related issues of law, as we shall need to return to those when
summarising our conclusions. The common or related issues of law are:
(1)
Whether the profit arising from the loan note and appropriated to pay up
the issue premium on the shares, was “required to be transferred to the share premium
account” within the meaning of FA 1996, s 84(2)(a).
(2)
Whether the amounts which are required to be transferred to share
premium account are within the meaning of “profits or gains and losses” for the
purposes of FA 1996, s 84(1)(a).
(3)
Whether the amounts taken to the share premium account are to be brought
into account for the purposes of calculating tax under the loan relationship
rules and are not, therefore, subject to tax.
(4)
Whether FA 1996, Sch 9, para 12 applies in the present case, and, if so,
excludes the “share premium” profit arising to the Appellant from the scope of s
84(2)(a).
9. It
will be apparent from this that the first three issues essentially arise out of
the dispute as to the meaning and effect of s 84(2)(a); the fourth issue is as
to the application of para 12, Sch 9.
The facts
10. We had a helpful
statement of agreed facts, which we reproduce below, and we also had reports
from expert witnesses as to accountancy called by each of the parties, and a
joint experts’ report which those witnesses helpfully provided. Each of those
accountancy experts, Mr Andy Simmonds of Deloitte LLP for the Appellant and Mr
David Henworth, an advisory accountant within HMRC, for the Respondents, also
gave oral evidence under cross-examination.
Statement of agreed facts
1. The Appellant is
a UK-resident company, incorporated in England and Wales and at all material
times was a subsidiary of Brixton plc, a publicly-quoted company.
The Loan Notes
2. On 18 December
2003, Brixton plc subscribed for zero coupon loan notes (“the Loan Notes”)
issued by each of the following companies (“the Borrowers”) in the following
amounts:
a. Brixton Northfields (Wembley) Holdings Limited (formerly known as
Stylescore Limited), with a face value (“Principal Amount”) of £35,483,871 and
purchased for the issue price of £33,000,000;
b. Brixton Northfields 1 Limited, with a Principal Amount of £6,892,473
and purchased for the issue price of £6,410,000;
c. Brixton Northfields 2 Limited, with a Principal Amount of £548,387
and purchased for the issue price of £510,000;
d. Brixton Northfields 3 Limited, with a Principal Amount of £4,021,505
and purchased for the issue price of £3,740,000;
e. Brixton Northfields 4 Limited, with a Principal Amount of £3,924,731
and purchased for the issue price of £3,650,000; and
f. Brixton Northfields 5 Limited, with a Principal Amount of £4,505,376
and purchased for the issue price of £4,190,000.
3. The aggregate
Principal Amount of the Loan Notes was £55,376,343, payable on 17 December 2004.
Each of the Loan Notes was issued at a 7% discount to the Principal Amount with
the discount representing a commercial return on the funds advanced. The total
issue price paid by Brixton plc for the Loan Notes was £51,500,000.
The Share
Subscription Agreement
4. On 5 January 2004
Brixton plc entered into an agreement with the Appellant (“the Share
Subscription Agreement”) for the subscription of 51,701,782 ordinary £1 shares
(“the Shares”) issued by the Appellant.
5. Under the Share
Subscription Agreement the parties agreed that the aggregate subscription price
for the Shares would be £55,376,344 (clause 2.2). Accordingly, each share would
be paid up £1 as to nominal value and £0.071 as to premium (clause 3.1).
6. The parties
agreed that, in payment up of the nominal value of the Shares, Brixton plc
would assign the Loan Notes to the Appellant (clause 3.2).
7. In addition, the
parties agreed that in payment up of the premium on the Shares the Appellant’s
directors would “resolve to capitalise all and any realised profits arising” on
the Loan Notes and “appropriate the sum resolved to be capitalised to the share
premium account” (clause 3.3). Brixton plc also undertook to pay any unpaid
premium, in the event that the amounts available from the Loan Notes were
insufficient, within 5 days of it being called by the directors of the
Appellant (clause 3.5).
Written
Resolutions of the Appellant
8. On 5 January 2004
by ordinary resolution the Appellant increased its share capital from £1,000 to
£51,702,782 by the [creation of] 51,701,782 ordinary shares of £1 each ranking pari
passu with the existing ordinary shares of £1 each.
9. On 5 January 2004
by special resolution the Appellant amended its articles of association by the
insertion of Article 4 which required the directors to:
a. capitalise all and any realised profits arising on the Loan Notes
whether accrued or received, within 30 days following 31 December 2004; and
b. appropriate the capitalised sum to the share premium account of the
Appellant and apply such sum towards paying up the unpaid premium in respect of
the Shares.
10. On 27 July 2004
by special resolution the Appellant amended Article 4 of its articles of
association to require the directors to “appropriate the sums to be capitalised
to the share premium account” and the application of such amounts towards the
unpaid premium of the Shares, within 15 days of each of the following dates: 31
July 2004, 30 August 2004, 30 September 2004, 31 October 2004, 30 November 2004
and 31 December 2004.
11. At meetings of
the board of directors on 12 August 2004, 2 September 2004, 1 October 2004, 1
November 2004, 1 December 2004 and 4 January 2005, the Appellant’s Directors
passed resolutions in accordance with Article 4 of its articles of association.
Accounting
treatment
12. As the date for
payment of the Loan Notes approached, the profits arising were incrementally
realised and posted to the profit and loss account. The Appellant transferred
them to the share premium account.
11. We were very
helpfully taken through a sample of the documents to demonstrate the
documentary basis for the facts as agreed. These included the corporate
resolutions from which there is little material to record by way of further findings
of fact. We would however mention the board minutes of the Appellant in
relation to the board meetings referred to at para 11 of the statement of
agreed facts, which in each case recorded that the directors had noted that the
company had positive distributable reserves, including in particular that none
of the investments or other assets held by the company were impaired, and that
no provisions were required to be made in respect of the profits arising on the
loan notes, and accordingly that all of the amount capitalised represented a
realised profit.
12. We should also
note, by way of clarification, that the reason why there was a difference
between the aggregate issue price of the loan notes (£51,500,000) and the
nominal amount of the shares issued by the Appellant under the subscription
agreement (£51,701,782) is that in the period between the date of issue of the
loan notes and the date of the share subscription the value of the loan notes
had increased, having regard to accruals, by the amount of £201,782.
Joint statement of accountancy experts
13. The accountancy
experts, Mr Simmonds and Mr Henworth, very helpfully provided a joint report.
As regards matters of expert opinion relevant to this case, there was no
dispute between the experts. We shall come on to one or two points that arose
during cross-examination of each of them, but we set out here a summary of the
matters of expert opinion on which they agreed.
(1)
Accounting recognition of the loan notes receivable and shares
issued
(a)
There was no share premium to recognise in the financial statements of the
Appellant on issue of the ordinary shares because the premium was not called or
paid at the date of issue.
(b)
The initial recognition by the Appellant in its balance sheet of assets
(the loan notes) with a value of £51,701,782 was in accordance with UK GAAP.
(2)
Accounting recognition of the accruals on the loan notes
(a)
The Appellant applied an accruals approach as an accounting policy
(recognising the interest (sic) income as it was earned) to reflect the
increase in the carrying amount of the loan notes as profit accrued on the
original loan principal.
(b)
Further, UK GAAP requires that profits realised at the balance sheet
date should be included in the profit and loss account.
(c)
The profit of £3,674,561 arising on the loan notes was a realised profit
in the Appellant’s profit and loss account for the period ended 31 December
2004 in accordance with UK GAAP.
(3)
Accounting recognition of the transfers to share premium account
(a)
The directors’ appropriation of the transfer of £3,674,561 from the
profit and loss account to the share premium account was undertaken in
accordance with the articles of association. (This is not strictly a matter of
accountancy opinion, but is not disputed.)
(b)
UK GAAP required those transfers to be reflected as movements in
shareholders’ funds (that is, a movement in reserves) because this was the
effect of this part of the transaction. This appears to be the accounting
which has been adopted by the Appellant although full disclosure of the
reserves movements as required by Companies Act 1985, Sch 4, Part III, para 46
was not included and the accounts anticipate the final transfer which was not
approved by the board until after the year end.
(c)
In the opinion of the experts, the accounting treatment of the transfer
as a movement in shareholders’ funds is in accordance with UK GAAP.
(4)
Accounting basis for the transfer to share premium account
(a)
Initially recording the income from the loan notes in the profit and
loss account was in accordance with UK GAAP (FRS3 “Reporting Financial
Performance”) which required that the income on the loan notes was first
recognised in the profit and loss account.
(b)
The transfer of the amount equal to the income on the loan notes,
£3,674,561, from the profit and loss account to the share premium account was
required by the articles of association (see above). The accounting treatment
of that transfer as a movement in shareholders’ funds was in accordance with UK
GAAP.
(c)
In the opinion of Mr Henworth, and in accordance with the company law
assumptions provided to Mr Simmonds, the share premium of £3,674,561 on the
shares was equal to the profit which accrued on the loan notes after their
assignment to the Appellant.
(d)
There is no alternative accounting treatment.
14. We should
clarify one point from this summary. Although the experts refer to the
recognition of interest income, it will be apparent from the agreed facts that
the loan notes in question were zero coupon, or discounted, securities. There
was no interest coupon. The profit arose by an accrual of the increase in
value of the security from its issue price (or, in the case of the Appellant,
its acquisition value) as the loan notes approached maturity.
15. There are only a
few additional points to record arising out of the cross-examinations of the
experts.
16. Mr Simmonds was
asked whether, on a straightforward direct subscription by an investor for
shares at a premium, the amount would go straight to share premium account, and
not be carried first to any other reserve. Mr Simmonds said that within the
bookkeeping system there would often be instances where cash would be received
for a public subscription before the shares were allotted, and the amount might
then be posted to a holding account, which could be called a subscription
account or an allotment account. Once the shares were allotted, the transfer
would be made to share premium and the share capital. But in a case where a
known subscriber simply subscribed for shares at a premium, Mr Simmonds
confirmed that the premium amount would go directly to share premium. This
would apply whether the subscription was for cash or on a capitalisation of a
debt.
17. Mr Simmonds clarified
the joint report conclusion that UK GAAP required the transfers from profit and
loss account to the share premium account to be reflected as movements in
shareholders’ funds. The accrual of income was correctly accounted for as part
of the profit and loss account. That was on account of the fact that this
would affect the amounts of assets and liabilities that were stated in the
balance sheet. The resultant aggregate amount accounted for in the profit and
loss account would then be the amount of the profit and loss reserve. The
transfer from that reserve to another reserve, namely share premium account,
would not affect the assets and liabilities, and so would not itself be a
profit and loss account movement.
18. Mr Simmonds also
confirmed that if the Appellant had not appropriated the accrued profit on the
loan notes and capitalised it in the way it was obliged to do, the balance of
the profit and loss account would have been carried as a balancing figure to
the profit and loss reserve.
19. Mr Henworth’s
report expressed opinions on the accounting treatment of the borrowing
companies, and the parent company. As the tax positions of those companies
were not in issue in this appeal, we took no account of those opinions. The
report also contained a number of assertions of opinion on fact and law that
were outside the scope of accountancy expertise. A number of instances of this
were put to Mr Henworth in cross-examination. We need not record them; it
suffices for us to say that in relation to any questions of fact and law that
were a matter for determination by the tribunal we have paid no regard to the
expressions of opinion by Mr Henworth.
The law
20. This case is
concerned with the tax treatment of loan relationships. At the material time,
the relevant provisions were contained in Chapter II of Part IV of the Finance
Act 1996. Those provisions were themselves amended after the time relevant to
this appeal; we set out the relevant provisions as in force at the material
time.
21. Section 80 FA
1996 sets out the basic position that for the purposes of corporation tax all
profits and gains arising to a company from its loan relationships shall be
chargeable to tax as income in accordance with Chapter II. The loan notes
evidence loan relationships in this case. The Appellant was, following the
assignment, a creditor in respect of the loan notes, and accordingly its loan
relationship was a creditor relationship (FA 1996, s 103(1)).
22. Section 82
describes the method of bringing amounts into account for tax. Sub-section (1)
provides:
“(1) For the purposes of corporation tax—
(a) the profits and
gains arising from the loan relationships of a company, and
(b) any deficit on
a company's loan relationships,
shall be computed in accordance with this section
using the credits and debits given for the accounting period in question by the
following provisions of this Chapter.”
23. The tax position
is thus ascertained by reference to credits and debits as provided for by
Chapter II. It is s 84 that sets out the basic rule, and which is material to
the first of the issues we have to consider. So far as material it provides:
“(1) The credits and debits to be brought into
account in the case of any company in respect of its loan relationships shall
be the sums which, in accordance with an authorised accounting method and when
taken together, fairly represent, for the accounting period in question—
(a) all profits, gains
and losses of the company, including those of a capital nature, which
(disregarding interest and any charges or expenses) arise to the company from
its loan relationships and related transactions; and
(b) all interest under
the company's loan relationships and all charges and expenses incurred by the
company under or for the purposes of its loan relationships and related
transactions.
(2) The reference in subsection (1) above to the
profits, gains and losses arising to a company—
(a) does not include a
reference to any amounts required to be transferred to the company's share
premium account; but
(b) does include a
reference to any profits, gains or losses which, in accordance with generally
accepted accounting practice, are carried to or sustained by any other reserve
maintained by the company.
…
(5) In this Chapter “related transaction”, in
relation to a loan relationship, means any disposal or acquisition (in whole or
in part) of rights or liabilities under that relationship.
(6) The cases where there shall be taken for the
purposes of subsection (5) above to be a disposal and acquisition of rights or
liabilities under a loan relationship shall include those where such rights or
liabilities are transferred or extinguished by any sale, gift, exchange,
surrender, redemption or release.
(7) This section has effect subject to Schedule 9 to
this Act (which contains provision disallowing certain debits and credits for
the purposes of this Chapter and making assumptions about how an authorised
accounting method is to be applied in certain cases).”
24. Section 84
contains the basic rule. Sub-section (7), however, directs attention to Sch 9,
and the special provisions that can apply. One such provision is that in para
12, which contains special computational rules for certain transactions between
group companies. So far as material, para 12 provides:
“(1) Subject to paragraph 15 below, this paragraph
applies where, as a result of—
(a) a related transaction between two companies that
are—
(i) members of the same
group, and
(ii) within the charge
to corporation tax in respect of that transaction,
(b) a series of transactions having the same effect
as a related transaction between two companies each of which—
(i) has been a member of
the same group at any time in the course of that series of transactions, and
(ii) is within the
charge to corporation tax in respect of the related transaction,
…
one of those companies (“the transferee company”)
directly or indirectly replaces the other (“the transferor company”) as a party
to a loan relationship.
(2) The credits and debits to be brought into
account for the purposes of this Chapter in the case of the two companies shall
be determined as follows—
(a) the transaction, or series of transactions, by
virtue of which the replacement takes place shall be disregarded except—
…
(ii) for the purpose of
identifying the company in whose case any debit or credit not relating to that
transaction, or those transactions, is to be brought into account; and
(b) the transferor company and the transferee
company shall be deemed (except for those purposes) to be the same company.”
25. Company law
imposes requirements on the issue of shares at a premium. Prior to s 56 of the
Companies Act 1948 having effect, and apart from any provision in the articles
of association, there was no legal objection to a company making a distribution
out of share premium by way of dividend. The change in law by s 56 effectively
assimilated share premium to share capital. For present purposes the rule is
found in s 130 of the Companies Act 1985:
“(1) If a company issues shares at a premium,
whether for cash or otherwise, a sum equal to the aggregate amount or value of
the premiums on those shares shall be transferred to an account called ‘the
share premium account’.
(2) The share premium account may be applied by the
company in paying up unissued shares to be allotted to members as fully paid
bonus shares, or in writing off –
(a) the company’s
preliminary expenses; or
(b) the expenses of, or
the commission paid or discount allowed on, any issue of shares or debentures
of the company,
or in providing for the premium payable on
redemption of debentures of the company.
(3) Subject to this, the provisions of this Act
relating to the reduction of a company’s share capital apply as if the share
premium account were part of its paid up share capital.
(4) Sections 131 and 132 below give relief from the
requirements of this section, and in those sections references to the issuing
company are to the company issuing shares as above mentioned.”
26. It was common
ground that neither s 131 nor s 132 apply.
27. Although,
prompted by questions from the Tribunal, there was some discussion on the
applicability of s 130 in the circumstances of the share issue and
capitalisation of share premium in this case, the Respondents did not seek to
argue that s 130 does not apply. We are therefore not required to make any
findings in that respect. We are content to assume that the transfer to share
premium account was either a function of the obligations under the subscription
agreement and the articles of association and board resolutions of the
Appellant, or a function of those obligations together with s 130. Either way,
it is common ground that the applicability or otherwise of s 130 itself is not
determinative of this appeal.
Discussion
28. We turn first to
consider the rival submissions on s 84(2)(a). If we find for the Respondents
on that question, that will determine the appeal, and the Respondents will not
need to rely on para 12, Sch 9.
Section 84(2)(a)
29. Put shortly,
what the Appellant contends is that the transactions clearly fall within the
plain words of s 84(2)(a): the profits arising on the loan notes were required
to be transferred to share premium account. As such, it is said, s 84(2)(a)
provides a statutory injunction to remove such amounts from the scope of tax.
Mr Peacock submitted that s 84(2)(a) encompasses all profits that are required
to be transferred to share premium account. No distinction is drawn between
one type of share premium and another, nor between any accounting treatment and
another; nor does it ask how or why it is that an amount falls to be
transferred to share premium account. The only question is: “Have you been
required to transfer any amount?” It is the end result that matters.
30. Mr Ghosh
submitted that s 84(2)(a) is looking at a requirement for the transfer to share
premium account only at the time that the relevant amount arises as a profit on
a loan relationship. Accordingly, in this case the profits as they accrued
were required to be transferred to profit and loss account. There was at that
time no requirement to transfer to share premium account; the profit remained
in the profit and loss account until a movement on reserves was required when
the Appellant appropriated and capitalised the profit to share premium. Mr
Ghosh argued that it was not the end result that matters. The fact that there
is a present obligation to do something in the future with the profits does not
mean that there is no obligation, when the profit accrues, to transfer that profit
to the profit and loss account, nor that there is a requirement at that time to
transfer to share premium account.
31. There was no
argument that the transactions should be analysed on the basis that they were
concerned with tax avoidance. Nor did we receive any evidence on whether the
transactions were for commercial purposes. We make no findings in that
respect. We are here concerned purely with a question of statutory
construction.
32. It was common
ground that we should construe the relevant provisions purposively. Both
parties agreed that the starting point is the guidance given by the House of
Lords in Barclays Mercantile Business Finance Limited v Mawson [2005] STC 1 (HL) at para 36:
“The ultimate question is whether the relevant
statutory provisions, construed purposively, were intended to apply to the
transaction, viewed realistically.”
Here there is no dispute on the nature and effect of the
transactions. The only question for us is the purposive construction of the
statutory provisions.
33. The parties agreed
that the wording of s 84(2)(a) reflected, in its reference to “transferred to
share premium account”, the similar wording in s 130. It is evident that the
draftsman of s 84(2)(a) had s 130 in mind when constructing the exclusion from
what would otherwise be profits, gains or losses arising to a company from its
loan relationships. We need therefore to consider why it was that such an
exclusion was considered to be required.
34. Mr Peacock
referred us to a number of case law authorities on the pre-1948 company law
position of share premium, before s 56 of the Companies Act 1948 (now s 130 CA
1985) had assimilated share premium to share capital. The question was whether
share premium was available for distribution by way of dividend. In Drown v
Gaumont-British Picture Corporation Ltd [1937] 2 All ER 609, it was held in
the High Court that the part of a reserve fund that consisted of monies paid by
way of premium on the issue of shares was generally available for dividend
purposes. In a case which considered the post-1948 position, Re Duff’s
Settlement [1951] Ch 721, Harman J held that the effect of s 56 was that
money paid out of share premium account is to be treated as capital and not as
income. This conclusion was confirmed by the Court of Appeal [1951] Ch 923.
35. In the High
Court, at page 724, referring to Drown, Harman J remarked that before
the 1948 Act the sums received by companies as premiums on the allotment of
shares ranked as profits available for payment of a dividend. He goes further
(at p 727), confirming that, even after the 1948 Act, share premium “represents
a profit in the sense that the company got more for its shares than their
nominal value” albeit not, after s 56, a distributable profit.
36. On this basis Mr
Peacock developed his argument that in 1996 the draftsman was alive to the fact
that, notwithstanding that s 130 would make a profit non-distributable, a
transfer to share premium account would not of itself prevent a profit arising,
and that if that profit was from a loan relationship or related transaction, it
would have to be excluded so as to make it not taxable in the hands of the
recipient. Mr Peacock submitted that one could infer that as a matter of
policy it had been determined that if something was added to the share capital
of the company, albeit through the mechanism of the share premium account, and
by virtue of that became non-distributable, that should be something that was
not charged to tax in the hands of the recipient.
37. Mr Ghosh argued
in this respect that the company law authorities were not to do with whether
the share premium is a taxable profit in the hands of the company which books
the amount to share premium account. Instead, the cases were concerned with
the quality of a dividend in the hands of the recipient. We accept, of course,
that the cases had nothing to do with taxation of profits of the company. But
they do demonstrate the fact that, even after the assimilation of share premium
to share capital, a share premium is itself a profit, albeit one that is not
distributable, and can be reduced only in the same way as share capital. The
important point, we consider, is that share premium could represent a profit,
and that the draftsman evidently considered that there were circumstances in
which such a profit ought not to be taxable under the loan relationships code.
The legislative purpose of s 84(2)(a) was to eliminate the charge to tax in
those circumstances.
38. What we need to
consider, therefore, is the circumstances in which s 84(2)(a), properly construed,
does have that effect. The argument of Mr Ghosh proceeds on the basis that a
profit once identified and carried, according to GAAP, to profit and loss
account is a taxable profit, and that a transfer of that profit to share
premium account, even pursuant to an obligation to do so that exists at the
time of the profit accrual does not exclude that profit from the ambit of s
84(1)(a).
39. Mr Peacock points
to the language of s 84(2)(a), and in particular the use of “transferred”, importing
the term used in s 130 CA 1985. Mr Peacock argued that this connoted a
transfer from one place to another, and must at the least include a transfer
from one reserve to another. He submitted that there could be no basis for concluding
that where the draftsman talks of “transferred” he means only a direct credit
to share premium account.
40. Mr Ghosh on the
other hand argued that, in this context, “transferred” means nothing more than
a movement, in the same way as one might have on a direct subscription for
shares or on the issue of shares at a premium on the extinguishment of a debt,
when a transfer to share premium account is required.
41. We do not
consider that the use of the term “transferred” in the context of a requirement
that share premium be taken to share premium account is determinative. It is
clear that the term can encompass all means whereby share premium is credited
to share premium account. A share premium may be required to be credited to
share premium account without first being credited to any other account or
reserve, or, as in this case, it might first be required to be credited to
another account or reserve, such as the profit and loss account or reserve, and
then transferred, by a movement on reserves to share premium account. But the
mere use of the term “transferred” does not lead to the conclusion that all
such transfers to share premium account must fall within the ambit of s
84(2)(a).
42. In our view, the
effect of s 84(2)(a) is limited to excluding profits that arise only by reason
of the relevant amount being a share premium, and accordingly being required to
be transferred to share premium account. It does not exclude profits that
accrue to, and are carried to, any other account or reserve. Accounts that are
purely internal administrative accounts such as suspense accounts on certain
share subscriptions, in which an amount paid as a share premium might
temporarily be held prior to the premium being transferred directly to share
premium account, can be disregarded. On the other hand, a profit that is credited
to profit and loss account is not excluded from the meaning of “profits, gains
and losses” in s 84(1) by a subsequent transfer to share premium account, even
if there is an obligation to make such a transfer at the time the profit
accrues.
43. We consider that
this construction is supported by the context in which s 84(2)(a) falls to be
construed, and by its discernable purpose.
44. Firstly, s
84(2)(a) must be considered along with s 84(2)(b). Mr Peacock drew our
attention to the fact that (b) uses the language of profits, gains or losses
being “carried to or sustained by” any other reserve. Although this can be
contrasted with the use of “transferred” in (a), we do not, for the reasons we
have given, consider that this indicates anything other than that the draftsman
had s 130 CA 1985 in mind when drafting (a). We ourselves note, on the other
hand, that whereas (b) refers to “profits, gains or losses”, (a) refers only to
“amounts”. We consider that this is a strong indication that s 84(2)(a) is
confined to cases where there is no pre-existing profit etc that has been
required to be carried to any other reserve, and that it accordingly
encompasses only cases where the premium has been transferred directly to share
premium account.
45. A clear contrast
is drawn in s 84(2) (and this is in our view emphasised by the use of the
conjunction “but”) between cases where an amount is transferred to share
premium account and cases where profits, gains or losses are carried to or
sustained by other reserves. In our view the scheme of s 84(2), taken as a
whole, is to ensure that only amounts which would not otherwise for any reason
be profits, gains or losses, but which are transferred to share premium
account, are excluded from being profits, gains or losses within s 84(1)(a).
Amounts which are profits, gains or losses carried to or sustained by any other
reserve are within s 84(1)(a), and are not taken out of the meaning of that
expression by subsequently being transferred to share premium account, even if
the company is obliged to make that transfer.
46. It follows
therefore that we agree with the submissions of Mr Ghosh. The time at which both
s 84(2)(a) and (b) operate is, in our view, the time when the profit accrues.
That is the material time at which the taxability of an amount must be
determined. In this case the profit accrued to profit and loss account, and at
that time the profit fell to be taken into account. We do not accept Mr Peacock’s
submission that s 84(2)(a) looks to the end result. Once a profit has accrued
and been credited to profit and loss account, we do not consider that a
subsequent transfer to share premium account, even under a pre-existing
obligation, can de-nature such a profit, so that it becomes non-taxable.
47. The reference in
s 84(2)(a) must, in our view, be construed so as to mean a present requirement
to transfer at the time the profit accrues. It does not, in our judgment,
encompass an obligation which exists, but as regards which the company will be
required to make the transfer only at some time in the future (which may be
very shortly afterwards). There can be no requirement to make the transfer
unless and until the capitalisation has taken place. The requirement to
transfer to share premium account does not arise until a premium is contributed,
by subscription or capitalisation or otherwise. It does not matter whether the
company is obliged contractually or under its articles to effect the
capitalisation. That merely amounts to a present obligation which, when
satisfied, will at that stage give rise to the requirement to transfer an
amount to share premium account. Until then the requirement to transfer to
share premium account is not a present requirement.
48. In our judgement
this analysis accords with what we perceive to be the purpose of s 84(2)(a).
We regard the evident purpose of that provision to be to take out of account
for tax on loan relationships an amount which would be a profit only by virtue
of its being a premium on the issue of shares, and not for any other reason.
As we have described, under company law, despite the assimilation effect of s
130 CA 1985, a share premium, in the words of Harman J in Re Duff’s
Settlement, represents a profit in the sense that the company gets more for
its shares than their nominal value. One can readily appreciate why that
possible outcome was something that Parliament would not be seeking to tax,
even if the “profit” that was represented by the premium arose from a loan
relationship. But the mere transfer to share premium account of a profit that
has otherwise arisen on a loan relationship, and which has been accounted for
under GAAP as such, cannot, in our view, have been within the intendment and
purpose of the exclusion under s 84(2)(a). And this remains the case even if
there are pre-existing obligations at the time that profit accrues that will
result in that profit being transferred to share premium account. Furthermore,
we do not accept that the intention was to exclude a profit because it became
non-distributable. The intention was to exclude a profit that arose purely
because it was a premium; such a profit would, by virtue of s 130 CA 1985, at
no time be distributable.
49. Perhaps the
paradigm example of the application of s 84(2)(a) is the case of the extinguishment
of a debt of £100 in exchange for the issue of 10 £1 shares. In such a case a
creditor has effectively subscribed for the shares at a premium of £90. That
premium must be transferred to share premium account. In company law terms,
the £90 represents a profit. The company has received value, in the form of
debt release, of £100 in consideration for an issue of shares of £10. Without
more, that profit on the debtor relationship of the company could be regarded
for the purposes of s 84(1) as a profit arising on the company’s loan
relationship. Unless excluded, that profit could be represented by a credit to
be brought into account to corporation tax. Section 84(2)(a) prevents that
consequence. It does so because the only reason why the amount of £90 could be
a profit is because it is a premium. Nothing else in respect of that loan
relationship has given rise to any profit accrual. If there had been some
other accrual or recognition of profit for accounting purposes, s 84(2)(a)
would not apply merely because that profit had to be transferred, even under a
pre-existing obligation, to share premium account.
50. Mr Peacock
argued that this construction would be to narrow the meaning and scope of s
84(2)(a). He argued that the section expressly applied to “any” amounts
required to be transferred to share premium account, and that there was no
principled basis upon which those words could be given a narrower construction
so as to create separate sub-categories of share premium which do or do not
qualify for relief. We do not consider that the construction we have placed on
s 84(2)(a) is aptly described as a narrow construction; in our view it is a
principled and purposive construction. We do not regard the use of the word
“any” as militating against a purposive construction which recognises that the
section is looking at those amounts, and that transfer, when considering
whether they are or are not to be regarded as profits, gains or losses arising
to the company. The use of the word “any” has no significance in this context;
it does not, in our view, extend the scope to any amounts that are profits
otherwise than by reason of being share premiums.
51. We base our
conclusion purely on the construction of s 84(2)(a) itself. In particular,
whilst we recognise that in many respects the loan relationships code does
provide for symmetry between the tax treatment of debtors and creditors to loan
relationships, this is not a universal rule, and has not provided an aid to
construction in this case, even on a contextual basis. The fact that the
Appellant’s submissions in this case, if correct, would have given rise to an
asymmetry in the treatment of the borrowing companies (which obtained a
corporation tax deduction for the accruing borrowing cost) as against the
Appellant, as creditor, which would not have been taxed on the corresponding
accrual of profit, has not been material to our decision.
52. Our conclusion,
therefore, is that s 84(2)(a) does not have the effect of removing the accrued
profits on the loan notes from tax. That is enough to dispose of the appeal,
but in case this appeal goes further, and in light of the submissions we have
received, we turn now to the issue of the effect, if any, of para 12, Sch 9 FA
1996.
Para 12, Sch 9 FA 1996
53. Were we to have
decided that the Appellant was right on s 84(2)(a), the Respondents argued that
para 12, Sch 9 operates to exclude the “share premium” profit arising to the
Appellant from the scope of s 84(2)(a).
54. We will consider
this contention by looking first at the wording of para 12, focussing in
particular on para 12(2); we will then outline Mr Ghosh’s contentions, and Mr
Peacock’s response; and then give and explain our decision.
55. Paragraph 12
makes provision for certain special computational rules for groups of
companies. There was no dispute between the parties that the conditions for
its applicability in this case were satisfied. The assignment of the loan
notes from the parent company to the Appellant was a “related transaction”
between companies in the same group as a result of which the Appellant directly
replaced the parent company as a party to the loan relationship.
56. The dispute
centred on the extent and effect of the disregard provisions of para 12(2).
Although we have set out that sub-paragraph above, it is convenient to remind
ourselves of its wording;
“(2) The credits and debits to be brought into
account for the purposes of this Chapter in the case of the two companies shall
be determined as follows—
(a) the transaction, or series of transactions, by
virtue of which the replacement takes place shall be disregarded except—
…
(ii) for the purpose of
identifying the company in whose case any debit or credit not relating to that
transaction, or those transactions, is to be brought into account; and
(b) the transferor company and the transferee
company shall be deemed (except for those purposes) to be the same company.”
57. Paragraph 12(2)
contains two possible statutory fictions. The first is that, subject to the
exception in sub-paragraph (ii), the related transaction must be disregarded. The
second is that, subject to the same exception, the transferor company (here the
parent company) and the transferee company (the Appellant) are the same
company.
58. The purpose and
effect of para 12(2) in the normal situation of an intra-group transfer of a
loan relationship are relatively straightforward. Should the assignment itself
be effected at a price that would ordinarily occasion debits and credits, the
assignment and those debits and credits are to be disregarded. Only the
assignment is ignored, however. The accrual of interest, or profit on a
discounted security (depending on the nature of the loan relationship) on the
assigned loan relationship are not ignored, and they are allocated to the
assignor and assignee in accordance with the normal basis of recognition of
those items.
59. In this case,
therefore, prior to addressing Mr Ghosh’s contentions, para 12(2) would have
little effect. The parent company assignor had already recognised the accrued
profit on the loan notes prior to the assignment. The assignment was made at a
price that precisely reflected the accrued profit at the point of the
assignment. The price paid on the assignment itself would be ignored, but the
parent company accounted for an equivalent accrued profit, and the amount of profit
to be accrued in the assignee was reduced by a corresponding amount. In those
circumstances, on the assumption that the Appellant had succeeded on its s
84(2) argument, the assignee would be arguing that its accrual of profit on the
loan notes would be excluded from tax.
60. Mr Ghosh’s
contention, however, was that the assignment was a bilateral transaction. If
one disregarded the assignment, one should also disregard the share issue,
because that was itself merely part of the consideration for the assignment,
along with the inherently connected terms in relation to paying up the premium
on the issued shares by crediting later loan relationship profits to share
premium account. One did not disregard the later accruals because the loan
notes conferred that profit, quite apart from the assignment transaction, in
other words quite apart from the “related transaction”. But when one had to
disregard the share issue and the credit to share premium account, the
Appellant’s argument in this case that the accruals in its profit and loss
account should not be taxed because of a transfer to share premium account
would cease to fly, because one would be disregarding the feature that the
profit was later applied in paying up the premium on the shares, and thus the credit
to share premium account.
61. Mr Ghosh then
submitted that this result would neatly achieve the purpose of para 12, namely
the objective of ensuring that the quality of the debits and credits in respect
of the loan relationship itself would remain unchanged, notwithstanding the
intra-group transaction. He also observed that a feature that confirmed that
it was coherent that the share issue be disregarded was that the fiction of
treating the parent company and the Appellant as a single company (other than for
the purpose of accruing the profits on the loan relationship itself) the notion
of issuing shares to the issuer was unintelligible. Disregarding the share
issue thus avoided that absurdity.
62. In response, Mr
Peacock contended that Mr Ghosh was over-extending the purpose of para 12. The
first statutory fiction clearly required one to disregard the assignment of the
loan notes, but to extend the fiction to negate the share issue and the related
credits to share premium account was unwarranted. Mr Peacock referred to the
guidance recently summarised by the Supreme Court in DCC Holdings (UK)
Limited v Revenue and Customs Commissioners [2010] UKSC 58; [2011] STC 326,
to which we shall revert, and argued that:
(a)
the “related transaction” was simply the assignment of the loan notes,
and there was no occasion to ignore the share issue;
(b)
concluding that the share issue should not be disregarded, and
implicitly that the second statutory fiction (of treating the two companies as
one) did not apply in relation to a share issue that was unaffected by para 12,
led to the coherent result that the shares were still issued by one company to
another; and
(c)
the Respondents’ contention was purportedly affecting the quality of
credits that were not meant to be affected by para 12, which was inconsistent
with the purpose of the paragraph of dealing essentially with the treatment of
the related transaction alone.
63. Our decision in
relation to whether Mr Ghosh is right to say that para 12 would undermine the
Appellant’s case, were the Appellant to have succeeded on the s 84(2) issue is
as follows.
64. Since this issue
relates largely to identifying the extent of the effect of statutory deeming
provisions, it is we think appropriate first to summarise the principles of
construction of deeming provisions or statutory fictions recently articulated
by Lord Walker in DCC Holdings (at paras 37 – 39):
(1)
The normal principles of construction apply, but it must be recognised
that, by its very nature, a deeming provision involves artificial assumptions. It
will frequently be difficult or unrealistic to expect the legislature to be
able satisfactorily to prescribe the precise limit to the circumstances in
which, or the extent to which, the artificial assumptions are to be made.
(2)
A court is entitled and bound to ascertain for what purposes and between
what persons the statutory fiction is to be resorted to.
(3)
The words of a deeming provision should be given their ordinary and
natural meaning, consistent so far as possible with the policy of the Act and
the purpose of the provisions so far as such policy and purposes can be
ascertained; but if such construction would lead to injustice or absurdity, the
application of the statutory fiction should be limited to the extent needed to
avoid such injustice or absurdity, unless such application would clearly be
within the purposes of the fiction.
(4)
Because one must treat as real that which is only deemed to be so, one
must treat as real the consequences and incidents inevitably flowing from or
accompanying that deemed state of affairs, unless prohibited from doing so.
65. We consider that
the effect of para 12 can readily be ascertained by construing the words used
and by giving them their ordinary and natural meaning. But we should approach
the construction of the paragraph with due regard to its evident purpose. When
para 12 requires one to disregard the related transaction, it is important to
note that the paragraph, in common with the entire body of the relevant
legislation, is wholly directed to calculating loan relationship profits and
losses. It is therefore central to the purpose of para 12 that if the terms of
the assignment would otherwise occasion loan relationship profits and losses,
it is that effect that should be disregarded. That is the extent and the limit
of the statutory fictions.
66. Indeed, para 12 itself
contains a clear delineation of the statutory fictions: they each expressly do
not apply in identifying the company required to bring into account any debit
or credit not relating to the related transaction. So whereas the related
transaction, namely the assignment, and so the consideration which is part of
that related transaction, whether in cash or shares or otherwise, would fall to
be disregarded and thus not give rise to loan relationship profits or losses on
the related transaction itself, it is evident from para 12(2)(a)(ii) that
nothing in para 12 is intended to affect the accrual of profit on the loan
notes. That accrual derives from the loan notes themselves, and is not
occasioned by the disregarded “related transaction”. It then seems to us that
there is nothing in para 12 to lead to a requirement to disregard anything in
relation to credits and debits that arise from the accruals on the loan notes,
including the circumstances in which s 84(2)(a) might apply to those credits to
which we should, and must, have regard. We are essentially directed to disregard
the related transaction and to regard the Appellant and its parent company as
one company when dealing with the credits and debits that would otherwise flow
from that transaction; but required not to extend the disregard or the single
company fiction so as to modify the treatment of the credits and debits that do
not relate to that transaction.
67. Mr Ghosh argued
that the credit to share premium account did relate to the assignment, and so
the disregard and the single company fiction were not excluded by para
12(2)(a)(ii). He submitted that this was because the undertakings to carry out
the various transactions that resulted in the transfer to share premium account
was part of the related transaction, namely the assignment of the loan notes.
The assignment should be ignored, with the consequence that the issue of shares
and the transfer to share premium should be ignored.
68. To the extent
that Mr Ghosh can be taken to be arguing that the reference to credit in para
12(2)(a)(ii) can include the credit to share premium account, we reject that
submission. That credit, or transfer, is not of the nature of the credit or
debit to which (ii) is directed. We agree with Mr Peacock that the reference
to credits and debits in (ii) is confined to the statutory credits and debits
postulated by s 82 FA 1996, and cannot encompass some other credit such as that
which arises on a transfer to share premium account.
69. The credits in
question, and those which accordingly are not subject to the statutory
fictions, are the credits that represent profits in the profit and loss account
of the Appellant. The assignment of the loan notes cannot be ignored for this
purpose, and it follows in our view that the assignment and everything else
that flowed from it, including the capitalisation of profits and the transfer
of those profits to share premium account, are also not disregarded for the
purpose of applying any relieving provision that might affect such profits.
That would include, as in this case, were we to have found that s 84(2)(a)
applied as the Appellant argued, the exclusion of amounts transferred to from
profit and loss reserve to share premium account from being profits and credits
for tax purposes.
70. Finally we
consider Mr Ghosh’s submission that para 12(2)(a)(ii) would not operate in any
intelligible fashion if the quality of the credits, and the nature and tax
treatment of any “profit”, was changed by the fact of the related transaction,
namely the assignment. This was on the footing that the effect of para
12(2)(a)(ii) is to require there to be an allocation of credits arising on the
loan notes as between the parent company. Mr Ghosh argued that the very
purpose of para 12 in this respect is to preserve the tax treatment of the loan
relationship which is the subject of the related transaction, both before and
after that transaction, except to allocate the debits or credits, as the case
may be, between the parties to the related transaction.
71. We do not accept
that what we consider to be the proper analysis of para 12 gives rise to any
incoherence of the nature suggested by Mr Ghosh. The statutory disregard of
the related transaction and the deemed single company fiction do not apply to
credits or debits that are not related to the related transaction. There is
nothing incoherent in identifying as between the transferor company and the
transferee company to what extent each of those individual companies is
required to bring those credits and debits into account, and then applying the
normal rules of computation, including any exclusion by virtue of s 84(2)(a)
separately in the case of each individual company. That, it seems to us, is
the correct approach on a plain reading of para 12.
72. On the
assumption, therefore, that the effect of s 84(2)(a) is to take the accruals of
profit on the loan notes outside of the meaning of profit for loan
relationships purposes, we conclude that para 12 would not deprive the profit
accrued on the loan notes of the exclusion afforded by s 84(2)(a).
Summary of conclusions
73. We have
concluded:
(1)
Section 84(2)(a) FA 1996 does not have the effect of removing the
accrued profits on the loan notes from tax under the loan relationships rules.
The Appellant is accordingly liable to corporation tax on those profits.
(2)
If we had decided that s 84(2)(a) did remove the accrued profits from
tax, that result would not have been prevented by application of para 12, Sch 9
FA 1996.
Decision
74. For the reasons
we have given, we dismiss this appeal.
Lead case issues
75. We set out here
our formal responses to the lead case common or related issues of law. These
must of course be read in conjunction with our decision in the lead case.
(1)
Whether the profit arising from the loan note and appropriated to
pay up the issue premium on the shares, was “required to be transferred to the
share premium account” within the meaning of FA 1996, s 84(2)(a). There
was an obligation to transfer the profit arising from the loan note and appropriated
to pay up the issue premium. However, that obligation, and that transfer, did
not prevent the profit that had accrued to profit and loss account from being
within the meaning of “profits, gains and losses” in s 84(1).
(2)
Whether the amounts which are required to be transferred to share
premium account are within the meaning of “profits or gains and losses” for the
purposes of FA 1996, s 84(1)(a). Yes. Those amounts were the profits
accrued and accounted for in the company’s profit and loss account. Those are
within the meaning of “profits, gains and losses” in s 84(1), and are not
excluded from being within that meaning by being required to be transferred to
share premium account.
(3)
Whether the amounts taken to the share premium account are to be
brought into account for the purposes of calculating tax under the loan
relationship rules and are not, therefore, subject to tax. The amounts
taken to share premium account are not by virtue of s 84(2)(a) excluded from
being profits within s 84(1). Accordingly, the accrued profits on the loan
notes are subject to tax as profits arising to the company on its loan
relationships.
(4)
Whether FA 1996, Sch 9, para 12 applies in the present case, and,
if so, excludes the “share premium” profit arising to the Appellant from the
scope of s 84(2)(a). The conditions for the application of para 12 were
not disputed. Paragraph 12 does not, however, have the effect of excluding the
“share premium” profit from the scope of s 84(2)(a), if applicable.
Application for permission to appeal
This document contains full findings of fact and reasons
for the decision. Any party dissatisfied with this decision has a right to
apply for permission to appeal against it pursuant to Rule 39 of the Tribunal
Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application
must be received by this Tribunal not later than 56 days after this decision is
sent to that party. The parties are referred to “Guidance to accompany a
Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and
forms part of this decision notice.
ROGER BERNER
HOWARD NOWLAN
TRIBUNAL JUDGES
RELEASE DATE: 21 December 2011
